Asia Pacific Economic Outlook, September 2014: Weekend Reading

The latest edition of the Asia Pacific Economic Outlook from Deloitte Research LP gives a near-term outlook for China, India, Malaysia and Vietnam. According to the report authors, China is experiencing steady growth, though risks remain and India’s recently announced budget is comprehensive but lacks a clear road map. Further, Malaysia’s economy appears to be gaining momentum despite recent airline tragedies, and Vietnam’s growth outlook has been steady, though the economic influence of China continues to be strong.

China: Steady growth, but risks remain. China’s GDP grew 7.5% in the second quarter versus a year earlier, as expected. Almost half of the GDP increase was due to increased fixed asset investment, which was up 17.3%. This means that government stimulus continued to spur economic growth. Indeed the government reported that total social financing (the broadest measure of credit extended) increased 40% from May to June. The government also reported that government spending in June was up 26% from a year earlier. Net exports made a negative contribution to growth in the second quarter. The so-called mini-stimulus of the government clearly drove economic growth. The question now is whether growth can be maintained absent further government intervention. Moreover, further intervention will only exacerbate the problems of excessive debt and excessive, wasteful investment.

Looking forward, China’s purchasing managers’ index (PMI) for manufacturing rose from 50.7 in June to an 18-month high of 52.0 in July. The subindex for new orders rose strongly, suggesting that the government’s efforts to stimulate the domestic economy are paying off. Of course the stimulus has also contributed to an expansion of credit, which poses future risk to the economy. On the other hand, the PMI for services fell to a historic low. Clearly the stimulus is boosting goods-producing industries rather than service industries.

One area of significant financial risk in China concerns local government debt. This Chinese economy shifts to slower growth, some provinces are growing especially slowly. This is due to the shutdown of excess capacity in heavy industry. Consequently, governments in some of these provinces have decided to stimulate faster growth by investing in more infrastructure projects, which in turn require financing. These governments are likely accumulating yet more debt through off-balance-sheet vehicles—although they have not explicitly said so. If local governments are boosting debt, it raises questions about the degree to which the central government can restrain the growth of bad debt. It also increases the risk of default in the not-too-distant future.

India: A comprehensive budget that lacks a clear road map. Thegovernment of India released the highly anticipated annual budget for 2014–2015 in July. It tabled its strategies and plans amid high market expectations from the middle class and the industry. This was the first budget of the new government after a historic win at the center, and it is seen as an important statement of the government’s intent to deliver economic development.

The session, which lasted more than three hours (the longest budget session ever), was a mixed bag for all. Finance Minister Arun Jaitley unveiled a broad road map of policies and reforms to boost economic growth, which has slowed to below 5% over the last two years. The budget was incrementally positive, though there were no big changes, contrary to expectations. Several policies were proposed that covered many areas and had something for everyone.

Jaitley began by highlighting the challenges that the economy is currently facing. He then announced that the government aims for economic growth of 7% to 8% over the next three to four years, along with macroeconomic stability, lower inflation and lower fiscal and current account deficits. He also stressed the need for sharp fiscal correction, maintaining the previous government’s fiscal deficit target of 4.1%. In addition, he announced a fiscal deficit trajectory of 3.6% in FY 2016 and 3.0% in FY 2017. Undoubtedly, it is going to be a big challenge for the finance minister to stick to such a fiscal consolidation path. However, Jaitley’s explicit confirmation that the government will adhere to the fiscal plan may instill confidence.

Malaysia: Some cheer for the economy amid tragedy. In July, Malaysia Airlines’ Flight MH17 from Amsterdam to Kuala Lumpur was shot down over Ukrainian airspace. The tragedy came barely months after the disappearance of another Malaysia Airlines plane (MH370) on its way to Beijing from Kuala Lumpur. The twin tragedies have left the country shaken. They have also led to concerns regarding the future of the airline as well as tourist inflows into Malaysia. Luckily, the latter has not been affected much. Tourist arrivals grew 9.9% year over year during January through April despite a 0.9% dip in arrivals from China. Moreover, the wider economy appears to be gaining momentum despite headwinds from high household debt, rising price pressures and slower government spending.

GDP growth went up to 6.2% year over year in Q1 2014 from 5.1% in Q4 2013 on the back of strong exports performance. Real exports grew 7.9% in Q1 2014, the fastest pace in about four years, as rising external demand pushed up sales of electronics and electrical goods and petroleum products. Domestic demand growth held steady during the quarter, with consumer expenditure and fixed investment growing at 7.1% and 6.3%, respectively. The latter was primarily due to a 14.1% rise in investments by the private sector, which more than made up for the 6.4% decline in public sector investment. This shows that businesses remain positive, auguring well for the economy in the coming months.

According to Bank Negara (BN), GDP growth is likely to be in the range of 5.0% to 5.5% in the coming quarters, thereby pushing annual GDP growth for 2014 close to the upper part of BN’s 4.5% to 5.5% forecast.* Business surveys appear to buttress that view, with the Malaysian Institute of Economic Research’s Business Conditions Index rising for the fourth straight quarter in Q2 2014. Industrial data also point to improved economic activity. Output went up 6.0% year over year in May, outpacing both the forecasts and the 4.2% rise in the previous month.

Vietnam: Steady, though strong influence of China continues. Vietnam’s economic growth has been steadily improving due to strong growth in trade. After registering annual growth of 5.4% in 2013, GDP grew 5.0% in Q1 and 5.3% in Q2 of 2014. Improved global demand and successful trade negotiations helped export-oriented firms attain robust growth. The industry sector too has been performing well, as evident from the recent industrial production index numbers. The index rose 6.1% year over year in June 2014 and gained 5.8% in the first half of 2014. The purchasing managers’ index grew at its fastest pace in May since its launch in 2011. Improving external accounts, falling inflation and a stable exchange market have also contributed to macroeconomic stability.

While growth has been steadily improving, tension over the placement of a Chinese oil rig off Vietnam’s shore has impaired the relationship between both countries, adversely affecting the investment climate and therefore the growth outlook. Air transport and tourism between these two countries have also been affected. If intraregional trade with other Asian countries does not pick up in the coming quarters, Vietnamese exports may be hit. This will impact industrial production, which has been good since Q3 2013. Although these factors will likely keep growth below its potential, proactive economic policies may ensure that the impact is not significant.

Since 2003, Vietnam has followed pro-growth expansionary fiscal and monetary policies, even though the government has adopted a more cautious approach in response to high macroeconomic instability during 2010–2012. Nonetheless, the policy inclination remains tilted toward supporting growth.

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